As the stock market continues its pattern of record-level volatility, the hedge fund industry stands perplexed over a targeted ban on short selling that was supposed to help the markets find some equilibrium.
As the stock market continues its pattern of record-level volatility, the hedge fund industry stands perplexed over a targeted ban on short selling that was supposed to help the markets find some equilibrium.
“There are lots of reasons for shorts to be in place, and banning shorts is bringing liquidity out of the market,” said Richard Baker, president and chief executive of the Managed Funds Association in Washington.
The MFA has strongly opposed the Securities and Exchange Commission’s Sept. 19 emergency ban on short selling more than 800 banking and financial services companies.
The ban, which was originally scheduled to expire Thursday, could be extended at least until the third week of October, according to SEC spokesman John Nester.
“The idea was to ban the short selling while Congress debated the bailout plan,” he said.
Mr. Nester declined to comment on whether the fact that the bailout plan remains unresolved 12 days after the short-selling ban was enacted will lead to an extension of the ban.
The SEC hasn’t made an official decision as to whether the ban will be extended beyond Thursday.
However, if the actions of regulators around the world are any indication, the ban on the practice of borrowing stocks to sell and then buy back at a lower price for a profit could be around for a while.
The Financial Services Authority in London moved in lockstep with the SEC with its own ban on short selling financial stocks, but the FSA’s ban will last until at least mid-January.
Indonesian and South Korean regulators have also come on board recently with bans for the month of October.
The objective of global regulators is to try to close the loophole for regulatory arbitrage which could lead traders to foreign markets for short-selling opportunities.
For the MFA, which represents a $2 trillion hedge fund industry that is often charged with being the root of market and economic meltdowns, the experience has been a reality check.
Mr. Baker cited the example of $80 billion worth of convertible securities issued as part of a convertible-arbitrage strategy during the first eight months of this year.
The strategy basically involves lending money to a company in exchange for stock as collateral but also shorting that stock in order to hedge the risk that the stock collateral might go down.
“This year, 60% of the convertible-securities customer base was banks that were having their stock shorted as an insurance policy,” Mr. Baker said. “We were providing liquidity to banks while they were accusing the hedge fund industry of driving down their stock prices.”
The full rationale behind the ban has also been lost on some financial advisers.
“If the short-selling ban was so helpful, then what the hell happened on Monday?” when the Dow Jones Industrial Average lost a record 777 points, asked Thomas Orecchio, principal at Greenbaum & Orecchio Inc. in Old Tappan, N.J.
The Dow rebounded Tuesday with a 485.21-point gain.
“I have less of a problem with a temporary ban on short selling than I do with making the ban a [longer-term] part of the bailout,” Mr. Orecchio said. “Right now, people withdrawing their money are doing more damage to banks than short selling.”
